March 8, 2013

Wealth Recovery

A long time ago, I wrote about expected values. I had written a research paper for my econometrics class on house prices, and had created an “onion” model to figure out what happens in many scenarios. The onion model showed seveeral different possible outcomes in the short term, with a worst-case outcome in 2012. The model said, “House prices will go back up, even if unemployment stays high and inflation stays low. It’s just how long will change.” In the best case, we’d bottom in 2010, and in the worst case, in 2012. The model also predicted that 2012 was the most likely year. I ran a roulette simulation in the onion model, and 2012 outcomes were more likely than 2010 outcomes. Other models I came up with showed unemployment nearing normal around 2014 +- 2 years.

My models essentially said, “House prices will likely bottom sometime in 2012, then begin going back up. Unemployment will return to something between 5-6% sometime between 2012 and 2016, most likely in 2014.” I only got a B on the paper, since the professor believed roulette onion models didn’t work, and that I should have used a more traditional method, like a panel model. Turns out roulette onion models work better than Panel models, by quite a lot. The news reports coming in over the last few years have all matched my models. Models I wrote and didn’t update since 2010! I haven’t pulled in new data. I haven’t re-run the models. I haven’t updated the code. I finished the paper and put aside the work( frankly, because of how hard it is. The model takes a day to build a usable data set from raw data, and then run another 2 days before producing output I can analyze in Eviews. Without a paper or something to incentivize the work, it’s simply too much work to do for no reward. )

The models bothered me for one reason — the models said, “Inflation, labor force size, and unemployment are the largest driving forces in house prices. Unemployment and labor force size reductions crashes house price levels quickly, and inflation raises them slowly.” Essentially, this means that house prices will recover their nominal levels regardless of what happens — as long as we have inflation. We’ve recently been in a liquidity trap — this happened last in the great depression. We know this is true, since the federal reserve bank’s outstanding ratios are the highest they’ve ever been. This has kept inflation positive in an environment where deflation should have occurred. We dropped the value of our money by printing more. The model I created said, “Do this, and everything will look OK in the end — even if you never get the fundamentals right and put people back to work.” This is what bothered me about the model. The model showed me, in no uncertain terms, that a stable, inflating economy, will always look good on paper. Even small amounts of wealth( non-liquid assets tied to inflation, like houses ) will increase, while non-wealth will not.

This changes everything. It explains the productivity gap( why are wages not matching productivity? Answer — inflation. Inflating assets rise, while nominal assets stay the same. ), and it creates a trap. Inflating assets are fixed assets — land, housing, real capital. Nominal assets are virtual — bank accounts, salaries, labor prices. I once tried to explain this before, back in 2003, with a website I created called, “SecretPayCut”. Most Americans are losing real ground. Their quality of living has declined in this recession. And it’ll go this way forever — unless we can get unemployment down. Full employment is the only thing that counters this problem. The models don’t explain what changes to make — just what would happen under normal circumstances if we have a liquidity trap and high unemployment. A lot of the 99% movement thinks the effects they’re seeing are due to taxation and redistribution — when they’re normal results of inflation + unemployment. Unemployment means a supply/demand problem in the labor market. There’s not enough demand for labor, and there’s too much supply. Yet, we don’t have policies to help this.

Supply side changes:

1. Link H1-B to unemployment rate.

2. Increase federal funding for students ( in the form of grants ) linked to unemployment rate ( let people hide in school, and out of labor force ).

3. Link police subsidies to unemployment rate.

4. Create a national unemployment fund to distribute to individuals( based on some cost of living formula )as a form of long-term unemployment insurance. ( State run unemployment insurance remains, but is limited to a shorter time, like maybe 1 or 2 years ).

5. Create a guaranteed minimum income that you give to every citizen, always( rich and poor alike ), linked to unemployment rate( income high when unemployment high. This may also be a supply side change — it creates an incentive for people to give up looking for jobs — exactly what you want during a recession. Conversely, it creates a reserve pool of labor for booms )

6. Long term loan buy-downs, linked to unemployment ( essentially, the government steps in and pays your mortgage interest when you’re unemployed. This is a perverse incentive, so link it to unemployment, and don’t do it all when the rate is 5% or less. It keeps unemployed homeowners from selling, helping keep house prices up, and more importantly, keeping labor demand up. )

These 10 changes would all have to be carefully linked to unemployment — since some of them provide perverse incentives. But they also provide counterbalances to both booms and busts — during booms, the incentives are phased out, and people encouraged to work. During busts, the incentives roll in and encourage people to spend. Since our society votes with dollars( opposite of central planning ), we must always have the dollars in people’s hands…